Hedge-Fund Manager: Small Banks Are the Real Problem

Forget megabanks. Small banks are riskier and in worse shape, says a former banking analyst and current hedge-fund manager.

Small-bank trade groups have been whining a lot about "too big to fail" banks, writes Thomas K. Brown, who runs a hedge fund investing in financial-services companies. As he sees it, they should do less griping and more banking.

"Say what you want about the boundlessness of Wall Street greed," Brown writes on his blog, BankStocks.com, "large banks are more broadly diversified, both by loan and product type, than small banks are. Too many small banks are simply money spigots for local developers. That's why the vast majority of bank failures (and FDIC losses) this past cycle were related to smaller banks."

"If big banks showed the same sort of loan concentrations of many community banks, regulators would force out their managements."

Too-big-to-fail banks don't have a government subsidy or special funding advantage because of their size, Brown says. That's all a myth.

"If anything, the all-in cost of funding of big banks is slightly higher than it is for smaller banks. Nor do big banks earn higher returns."

If size did offer a special advantage, big banks and other large financial institutions would be clamoring to be designated systemically important nonbank financial institutions. They are not.

Brown attacked the Independent Community Bankers of America for what he called its "series of sanctimonious statements." The ICBA is backing the Brown-Vitter bill that calls for higher capital requirements for large banks and easing regulatory burdens on small ones.

In an op-ed in American Banker, ICBA Chairman-elect John Buhrmaster stated: 'Despite the inevitable kicking and screaming from Wall Street, these reforms are essential to freeing up our markets and putting the 'capital' back in capitalism."

Actually, Buhrmaster is just interested in special treatment, says Brown, who calls the Brown-Vitter capital standards "unreasonably high." Small banks can compete against big banks and win. The ICBA, he says, has "resorted to whining and misleading in a shameful, unpatriotic effort to put one group of banks at a disadvantage while engaging in an unseemly attempt to secure a handout for the banks in their organization. It’s a disgrace."

A report from Goldman Sachs, one of the large banks, disputed the purported subsidy for large banks, according to Bloomberg. Bond investors don't see any subsidy. The largest banks have an average funding cost advantage of 0.31percentage point since 1999, but now the large banks pay an average 0.1 percentage point more for borrowing, it says.